Equivalent variation

Equivalent variation

Equivalent variation (EV) is a measure of how much more money a consumer would pay before a price increase to avert the price increase. Because the meaning of "equivalent" may be unclear, it is also called extortionary variation. John Hicks (1939) is attributed with introducing the concept of compensating and equivalent variation.

It is a useful tool when the present prices are the best place to make a comparison.

The value of the equivalent variation is given in terms of the expenditure function (e(cdot,cdot)) as

EV = e(p_0, u_1) - e(p_0, u_0)

= e(p_0, u_1) - w

= e(p_0, u_1) - e(p_1, u_1)

where w is the wealth level, p_0 and p_1 are the old and new prices respectively, and u_0 and u_1 are the old and new utility levels respectively.